Greece and money: Eurozone doomed no matter what!

I was watching CNBC’s coverage of the Greece crisis last week, and the views of one particular guest compelled me to write my first ever economics blog post. The gentleman in question was very well informed and made some interesting points. However, on the biggest issue of all he was completely wrong. According to him, “if Greece leaves the Euro, the Eurozone could collapse”. And he’s not the only one to use this logic, but in fact, the opposite is true: if Greece stays in the Euro (on Syriza’s terms), then the Eurozone will collapse. And here’s why:

We live in a fiat money world. Fiat money (i.e. money printed out of thin air) only works when people have faith in this money as a store of value. Central banks can print it and buy government debt, but there are limits as to how much printing and borrowing can be done. There is no magic number to quantify the limit, but the point is this: people will only buy debt if they think they will get their money back and fiat money only works if people believe it acts as a store of value.

If a country does not have enough money to repay its debts, it has two choices: default or print money (in that currency) to repay the debt. The first choice makes it very likely that it will not be able to borrow more (and therefore cannot spend more) and the second risks creating hyperinflation.

Greece defaulted on one of its loans last week. It wants to borrow more, but nobody wants to lend them more. Printing more to pay Greece’s bills won’t happen for two reasons:

1/ fairness. Why should one European country receive more fiat money (Euros) than another? This would obviously not be fair on those who are not spending as much (i.e. Germany).

2/ inflation. Printing money to finance a budget deficit can ultimately lead to hyperinflation. And if one Eurozone country can rely on the European Central Bank to print money and finance its budget deficit, no other country in the block would have an incentive to stick to the rules (and stay fiscally responsible): the incentive would be to spend-more-than-thy-neighbour.

As the US and UK have shown post 2008, quantitative easing (QE), if implemented correctly, does not lead to hyperinflation. This is because in this case, QE was not seen as a tool to finance a government deficit. Printing more money to pay for government spending would be a different story. That is why the ECB’s QE programme does not include Greek government debt.

So although Greeks may feel they are being bullied and victimised, this is not actually the point. I don’t know the exact details of what Syriza and the creditors are proposing but clearly Syriza want to keep spending and borrowing more. I feel for the many innocent Greek people, but if you keep saying “ok, we’ll give you this cash to do this (even though you wont be able to pay us back)” then the currency will eventually fail. A debt write off is an option, but this has already been tried and didn’t work. Also, if a creditor is going to write off debt, there needs to be goodwill from the other side. Are Syriza are offering this? Besides, critically, Syriza managed to turn a budget surplus into a budget deficit.

What all of this shows is that at the end of the day, whatever happens with Greece, the Euro is always going to be under threat from national politics. Until citizens of European countries give up their right to decide how much they borrow (relative to the size of their economy) and/or their right to negotiate like Syriza are doing now, then there will always be a risk of default and Euro collapse. I don’t see citizens giving up their rights, whatever happens in Greece.

And because of this constant uncertainty, businesses will always be cautious and think twice about investing in the real economy. This is why the Eurozone economy will keep lagging the UK and US. Ultimately, the Eurozone is doomed to failure whatever happens in Greece. In the short run markets want Greece to stay, but thinking slightly further ahead (i.e. six months), it would undoubtedly be better for the Eurozone if Greece to leave now. Why: because if Greece stays, then it strengthens Podemos’ (the Syriza-like left wing party in Spain) hand. If Podemos win the Spanish election later this year then Spain will want to renegotiate its debt, borrow more and spend more. That would be a far more significant than Greece, particularly since the ECB has already bought a ton of Spanish government debt. Italy and France would follow.

So, perversely, bad for Greece = good for the Eurozone and vice versa. What I’m saying is that Greece staying would lead to contagion, not the other way round as suggested by that good chap on CNBC.

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Note: these views are mine, and mine alone. They do not reflect those of my employer (past, present or future) or anybody that has or will pay me money. They are also subject to change, at the drop of a hat.